Living Wills: Are Banks Just 'Planning Their Own Demise'?

With American banks enmeshed in a fight for survival, they now have to show what happens if they don't make it.

As of Monday, major financial institutions — those once deemed "too big to fail" — were required to submit to regulators their so-called living wills. The plans would diagram how the banks would be broken apart should they find themselves unable to exist in their current form.

But the plan, part of the Dodd-Frankbanking regulations instituted in the wake of the 2008 financial crisis, may be for little more than appearance's sake should a similar-size catastrophe hit the banking system.

The reform sought, among other things, to make sure banks have enough capital to brace themselves against huge losses and not devastate the global financial system should they fail.

"Capital is like oxygen for banks. However, when your body is filled (with) cancer, as the case with European debt or stupid derivatives trades, it doesn't matter," Matt McCormick, portfolio manager at Bahl & Gaynor, told CNBC's "Squawk on the Street." "If these banks go out or (get) to the point where it's going to happen, in my opinion it's going to be from unforeseen circumstances."

McCormick pointed to the case of Dexia, the Franco-Belgian bank that needed to be bailed out after nearing collapse. The bank's troubles came even though it once boasted the highest capital ratio of its peers and easily passed bank stress tests.

"When you look at a living will on a personal situation, when you implement it, it still results in death," he said. "If any one of these banks go out, the consequences for all banks as well as the market are catastrophic."

Though banks have rallied over the past month, McCormick said the regulatory environment is one reason he wouldn't buy big U.S. financials.

"My answer is, avoid them," he said. "Buy the Canadian banks, buy high-quality dividend-paying stocks. You don't have to own these guys. I don't want to own something that is already planning for its own demise."

Defenders of Dodd-Frank and the living will provision in particular insist they are necessary measures to prevent another financial collapse. The wills force banks to identify ways in which they can unwind should they enter the too-big-to-fail realm.

Should banks fail to come up with a feasible plan, regulators then would step in, though that would be a last resort.

"I think a lot of progress can be made in having these firms make themselves more resolvable before you get to that point of actually imposing those severe remedies," John Simonson, the Federal Deposit Insurance Corp's deputy director of Systemic Resolution Planning and Implementation in the Office of Complex Financial Institutions, told Reuters.

Betting on Bank Stocks

Matthew McCormick, Bahl & Gaynor portfolio manager, provides his perspective on how to play big banks in an increasingly regulated environment.

Still, opponents bristle at the implications that Congressis hell-bent on taking down the large financial institutions that the U.S. needs to compete globally.

"If the regulators think about what is happening here, they also might be demoralized by Congress’ lack of faith in them," Rochdale Securities analyst Dick Bove said in an analysis for clients. "However, the FDIC enlivened by this legislation has already prepared its prescription of what should be done to dismember large banks."

The FDIC is mandating that equity holders be "wiped out" while debt holders would have their investments converted to equity that would be lesser in value, he added.

Bove has long railed against the increased regulatory environment against banks that were caught using too much leverage to cover bad bets in the real estate market during the past decade.

He has predicted a painful summer for bank stocksthat has not materialized yet, with the KBW Bank Index up 12 percent since hitting a six-month low in early June.

Still, he believes that provisions such as the living will make it harder for banks to survive, thus jeopardizing the economy.

"It is now time for analysts to look at these living wills and see what correlations exist among bank living wills — i.e., what businesses the banks as a group have demarcated as marginal. Then it is the job of the analysts to start pounding on banks to rid themselves of these businesses," Bove said. "Great job Congress, the American people really benefit by this one."